A special breed of preferred stock is multiplying on Wall Street. And with CD and savings account rates painfully low, the shares have a certain appeal as high-yield investments. They can make sense for investors willing to sacrifice some potential price gains in exchange for fat dividends.
Companies from General Motors to rjr Nabisco have issued PERCS, or preferred equity redemption cumulative shares. There are now close to $8 billion in PERCS outstanding, and most issues are large enough that it's easy to pick up shares in the secondary market. Like other preferred shares, PERCS are rated by the major rating agencies.
Here's how they work: A company issues preferred shares at the same price as its common. The shares pay a dividend significantly higher than that of the company's common stock--if the company is paying common stock dividends at all. The PERCS have a so-called capped price premium, usually 30% to 40% over the price of the common.
At the end of three years, the issuing company exchanges the PERCS either for cash or more typically for common shares, at market price or the capped price, whichever is lower. If a company's common stock price is below the capped price, the investor can get one share for each percs. But above the capped price, the investor will get less than one common share per PERCS.
The dividends on the shares can provide some cushion against falling prices when a company gets into trouble. Westinghouse Electric, for one, issued PERCS when its common stock was at $17. Westinghouse common was at $12.63 last week, but its PERCS were at $16.37.
But PERCS holders stand to miss out on big gains if a company's common stock really takes off, because percs' appreciation is limited by the cap.
SAY WHEN. Citicorp's PERCS were issued at $14.75, the same as its common stock that day. Since then, the common shares have risen to $19--but the PERCS are trading around $16.25.
"Investors should stick to common stock and look for companies with good growth possibilities," says Barry Murphy, director of marketing at the National Association of Investors, a group of investment clubs and individual investors.
Murphy suggests another alternative: traditional convertible preferred stock. This stock converts into a fixed number of common shares, no matter what the common share price is. And you decide when.
SOME HIGH-PAYING PERCs Issuer Yield Tenneco 9.50% Sears 8.72 Citicorp 8.25 RJR Nabisco 8.25 KMART 7.75 DATA: MORGAN STANLEY & CO.